June 8, 2011

June 8, 2011

The market’s malodorous tone has only intensified since my report of exactly one week ago, Wednesday, June 1st, when I noted that the combination of the phony follow-through of last Tuesday with the immediate next-day reversal on heavier volume was likely a sign of further lows to come. Since then, we’ve seen the major market indexes head sharply lower as they have sold off for six straight days. The daily chart of the NASDAQ Composite, below, looks like it wants to bee-line for the 200-day moving average down at around 2623. At this point the low of mid-April at around 2706 has been deeply undercut, so a drop down to the 200-day moving average followed by some sort of attempt at a bounce would appear logical. Of course, the last time the market looked this ugly, back on March 16th as I’ve noted on the chart below, it turned on a dime and headed to new highs. If you’ve shorted any of the short-sale target stocks I’ve discussed in recent reports and have decent profits, keep this in mind as we are approaching a logical area for a bounce. The NASDAQ has now corrected 7%, while the S&P 500 has corrected 6%, so we are in the lower reaches of a “short-term” correction.

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QE3 may still become a factor in some mutant form, and I think the clue in this regard is to watch the precious metals. The dollar has been coming down sharply since breaching its 50-day moving average last week, and despite a small bounce in the dollar today gold and silver held up reasonably well. The SPDR Gold Shares (GLD), shown below on a daily chart, has been forming a little cup-with-hande as of late. Silver is forming a shallower cup-with-hande on its daily chart, shown further below, but it is doing so from a position below its 50-day moving average. My general view, however, is that silver will follow gold, more or less, so one could theoretically play silver here using what gold, as represented by the GLD, does as a guide. The one potential issue with the precious metals is that a sharp sell-off in the stock market could create selling pressure on commodities in general as institutional investors, many of whom have large positions in the precious metals, may seek to raise cash and reduce these positions as well as they move to reduce their overall risk exposure. For now the ultimate selling guide for the GLD is the 50-day moving average at around 146, which might correspond to the 34-35 level in the SLV.

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What I would watch for here would be a potential pocket pivot in either the GLD, above, or the iShares Silver Trust (SLV), shown below on a daily chart. The GLD needs to move up from here, off of its 10-day moving average where it found support today, on volume that exceeds 13,553,100 shares, the highest down-volume in the pattern over the prior 10 days. SLV, on the other hand, needs to come up through its 10-day moving average at 36.23 on volume that exceeds 59,348,300 shares. For those of you who saw me on Fox Business News’ Stuart Varney & Company show yesterday (Tuesday) morning, you might have heard me refer to a “buy signal” in silver. If you look at the daily chart of the SLV, below, you can see that the magenta 10-day moving average line has crossed above the 20-day moving average, a very simple buy signal. Obviously, what we really want to see here is a pocket pivot up through the 10-day moving average since that would be the real buy signal/confirmation on the heels of this 10-day/20-day crossover. Watch for it.

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Apple, Inc. (AAPL) held its annual developer’s conference on Monday, and the stock reversed to the downside after a morning rally. Today AAPL announced a new “spaceship” headquarters office building, “the best office building in the world,” as Steve Jobs put it. The office building makes me think of historical stock market precedents where a big, juggernaut stock market leader begins building monuments to itself, and that marks the top. AAPL’s break below the 50-day moving average after an attempted trendline breakout last Wednesday, June 1st is in fact a possible late-stage failed-base (LSFB) type of short-sale set-up. Monday’s action provided the initial short-sale point up around 340, so I would watch for any rally from here to short into. I am well aware, as is the crowd, that AAPL is “cheap” at a mere 14 times forward earnings estimates. But when you consider that Research in Motion (RIMM) trades at a mere six times forward earnings, and it has continued to move lower in price, you can quickly appreciate how meaningless P/E is as an absolute measure of value but perhaps very meaningful as a measure of the market’s demand for a stock’s future earnings stream. The market certainly doesn’t value RIMM’s future earnings stream very highly, and so I would say that AAPL’s P/E is a similar red flag. In any case, the upside stop-loss on AAPL is either the 50-day line at 341.44, or the high of 3 days ago on Monday at 347.05, depending on your risk preferences. Meanwhile, AAPL held the 330 level, roughly near-term support, so a bounce from here would be logical.

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Travelzoo,Inc. (TZOO) has so far done everything we would have expected it to do based on the “Pin-Head & Shoulders” topping formation I pointed out a week ago in my June 1st report. Back then, six trading days ago, the stock was trading above the 70 level, and it did present in my view a “dialed-up” risk/reward combination. So far the stock has worked out well, as it broke down to a low of 58.10 before rallying off that intra-day low yesterday. This was well in excess of 15% to the downside, so a profit could have been booked anywhere between 58.10 and the low 60’s, in my view. Notice also that after today the stock is resting right on top of its neckline in the “PH&S” formation so a bounce from here would be logical. Thus for now I would look to short on any rally back up towards or into the 65-day exponential moving average, the black moving average on the daily chart below, at 66.66. Eventually, in a potential, sustained market correction or bear trend, I could see the stock getting to or near the $50 level, from whence it broke out in mid-March before going on its “double-climax” run from $50 to over $100 in a whirlwind upside move that took all of five weeks.

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Specialty workout-wear maker Under Armour (UA) is another example of a “Pin-Head & Shoulders” set-up, as we see in the daily chart below. This has a nice uniform look to it, which makes me suspicious since things that look this “perfect” may be too obvious. Nevertheless, UA has formed a pin-head with two shoulders on either side, and the stock is bumping against the neckline of the formation down at 62.50, more or less. Volume picked up today but was not above average, so I would look for this to attempt a bounce off the neckline, similar to what I was looking at in TZOO on the previous page. UA has had a decent run off the market lows of March 2009, and earnings growth has remained robust. Next quarter, however, earnings decelerate rapidly with only 14% growth expected. Retail stocks in general have been very weak lately as they discount what appears to be a rapidly weakening economy. UA just barely meets my daily average volume requirement of 1,000,000 shares per day, so is still on the thinner side. I would look for a bounce up into 64-65 price level to short into.

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Interdigital, Inc. (IDCC) is a Head & Shoulders type of short-sale set-up. The reason I haven’t discussed it until now is the fact that the stock trades less than one million shares a day, which is my lowest minimum requirement for short-sale target stocks with respect to minimum volume levels. Despite this lack of liquidity, I think the stock still provides a nice model of the “PH&S” set-up that one can use as a reference. Just looking at the weekly chart we can see how it has those critical features of a massive-volume breakdown down the right side of the “head” coupled with the look of “leaning” over to the right side on the weekly chart where the left shoulder forms above the right shoulder. Obviously this isn’t actionable here, and given that it only trades 782,000 shares a day I would not try to short it in any case. However, it does make a nice example of a PH&S short-sale set-up for your model book of historical short-sale examples.

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Finisar, Inc. (FNSR) was one of the first “poster children” of 2011 with respect to offering a prime example of the type of set-up and characteristics one is looking for in a head and shoulders top formation and the stock has worked very nicely on the downside as it gapped down today and broke below the 20 price level. It didn’t take FNSR’s earnings announcement on June 15th to send the stock lower, as I surmised over the weekend, as Ciena Corp.’s (CIEN) earnings announcement did the trick quite nicely, as we see in FNSR’s daily chart, below. This is a very heavy-volume gap-down move coming after five straight down days where the stock has broken to lower-lows. Given that the stock has come off nearly 30% since I first discussed it as a short-sale as it was forming the peaks of its right shoulders, this might be a good spot to take profits on what could very well be a near-term downside exhaustion gap. This might then set up a possible bounce from here that could provide a viable re-entry point. Remember also that earnings come out next week, so a bird in the hand may be worth two in the bush going into that announcement.

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Continuing to follow up on some of these short-sale ideas I’ve discussed in recent reports, Las Vegas Sands (LVS) finally separated from its 200-day moving average on Monday and moved lower, as we see on its daily chart, below. Today the stock came right down to the $40 price level where it found support 12 trading days ago. Volume was up today, so it is possible that the stock could break through this small area of support, but I would certainly look at shorting any bounce from here back up into the 200-day moving average. For now I would use the 200-day moving average as a trailing stop since LVS has yet to really break down in earnest. Given that I think the general market is in a position to try and bounce tomorrow or Friday, I would keep this in mind as I interpret the chart patterns of any short-sale position I may be currently working.

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Over the weekend I discussed the potential late-stage failed-base (LSFB) short-sale set-up in Sina Corp. (SINA), as well as the fact that I would look to short the stock on any bounce over the 115 price level. On Monday, SINA bounced up to 116.95 before turning tail and closing lower on the day on heavy, above-average volume, as you can see in the daily chart below. If you picked off that little rally on Monday, the stock plummeted about 20% or so from there over the next three days, finishing today at lower lows on very heavy volume. Note that SINA has now come down right on top of this short consolidation it formed back in mid-February to mid-March. This could provide a logical area at which the stock finds short-term support and stages a bounce. Certainly, the downside profits over the past three days have been swift, so one should not seek to be a pig here. I would look for SINA to rally back up into the 110 level before trying to short it again.

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Leaning towards the short side of the market a week ago based on the available, objective evidence in the general market indexes and leading stocks has so far put us on the right side of the market. But the indexes have come down six days in a row and both the S&P 500 and NASDAQ Composite Indexes look to be heading straight for their 200-day moving averages. Given that the downside in this market has become somewhat obvious, and a number of our short-sale target stocks have broken down to potential support levels, as I’ve discussed in the examples above, I would not be surprised to see the market try and bounce here. Thus if you are a short-seller in this market currently, be ready for this. Otherwise, if you have chosen to remain in cash, you are still doing a lot better than the market right now. As I wrote over the weekend, I still believe some mutant form of QE is going to be in the cards, but there is the possibility that QE2’s proven inability to create real economic growth, combined with the rapidly deteriorating economy means that any further QE will not help stocks. Thus I am leaning towards a scenario where more money-printing occurs in some form, sending the dollar lower and precious metals higher while stocks continue to languish. For now the market remains in a correction, a number of short-sale set-ups have worked well over the past week, and now we wait and see when and where the market tries to bounce, as we also keep an eye for pocket pivot buy points to show up in GLD or SLV.

Gil Morales

CEO & Principal, Gil Morales & Company, LLC

Principal and Managing Director, MoKa Investors, LLC

At the time of this writing, of the stocks mentioned in this report, Gil Morales, MoKa Investors, LLC, and/or Gil Morales & Company, LLC held positions in DGP and SLV, though positions are subject to change at any time and without notice. Gil Morales & Company, LLC (“GMC”), 8033 Sunset Boulevard, Suite 830, Los Angeles, California, 90046. GMC is a Registered Investment Adviser. This information is issued solely for informational purposes and does not constitute an offer to sell or a solicitation of an offer to buy securities. Information contained herein is based on sources which we believe to be reliable but is not guaranteed by us as being accurate and does